By Lucia Mutikani
WASHINGTON (Reuters) - U.S. employment increased solidly in June, but government hiring accounted for more than a third of the payrolls gain and the unemployment rate hit a 2-1/2-year high of 4.1%, pointing to a slackening labor market that keeps the Federal Reserve on course to start cutting interest rates this year.
The Labor Department's closely watched employment report on Friday also showed the economy created 111,000 fewer jobs in April and May than previously estimated, suggesting the trend in payrolls growth was slowing.
Annual wages increased at the slowest pace in three years as the labor pool expanded, adding to the flashing warning signals in the jobs market. About 277,000 people entered the labor force last month, accounting for the increase in the jobless rate from 4.0% in May to the highest level since November 2021.
When added to the moderation in prices in May, the report could boost Fed policymakers' confidence in the inflation outlook after the disinflationary trend was disrupted in the first quarter. Financial markets expect the U.S. central bank to start its easing cycle in September after it aggressively tightened monetary policy in 2022 and 2023.
"We now have definitive evidence of labor market cooling with a somewhat alarming rise in the unemployment rate in recent months that should give policymakers 'more confidence' that consumer inflation will soon return to the 2.0% target on a sustainable basis," said Scott Anderson, chief U.S. economist at BMO Capital Markets.
Nonfarm payrolls increased by 206,000 jobs last month, lifted by government hiring, the Labor Department's Bureau of Labor Statistics said. Economists polled by Reuters had forecast payrolls would increase by 190,000 last month, with the unemployment rate unchanged at 4.0%.
Job growth has averaged about 222,000 per month in the first half of the year. A lagging measure of employment, the Quarterly Census of Employment and Wages (QCEW), has suggested a much slower pace of job growth through the fourth quarter of 2023 than that of the payrolls data.
The QCEW data is derived from reports by employers to the state unemployment insurance (UI) programs. While economists expect employment to be revised down when the BLS next month publishes its payrolls benchmark estimate for the 12 months through March of this year, they argued that the QCEW data does not include undocumented immigrants, a group that they believe contributed to strong job growth last year.
Though hiring in June continued to be driven by acyclical sectors like healthcare and state and local governments, the share of industries reporting job growth jumped to 59.6% from 56.4% in May.
Government employment surged by 70,000 jobs, the most since December, boosted by local government, excluding education and state government. Private payrolls increased by 136,000, with the healthcare sector adding 49,000 positions, lifted by increased hiring in ambulatory healthcare services and at hospitals.
There was also an increase in social assistance employment.
Construction payrolls increased by 27,000 jobs. But the retail sector shed jobs, as did manufacturing. Professional and business services employment declined by 17,000 jobs, with temporary help employment dropping by about 49,000 jobs, the most since April 2020. That likely portends slower payrolls gains ahead.
"So far, we don't see apocalyptic signs within the labor market, but investors should be wary when the labor market is supported by government payrolls," said Jeffrey Roach, chief economist at LPL Financial. "The downward revisions to the previous two months is consistent with an economic slowdown."
Stocks on Wall Street were trading mostly higher. The dollar edged lower against a basket of currencies. U.S. Treasury prices rose.
WAGE GROWTH SLOWS
The 525 basis points worth of rate hikes from the Fed since 2022 as well as the exhaustion of excess savings accumulated during the COVID-19 pandemic are eroding demand.
Financial markets saw a roughly 72% probability of a rate cut at the Fed's Sept. 17-18 meeting. Traders are also pricing in a rising chance of a second rate cut in December.
The Fed has maintained its benchmark overnight interest rate in the current 5.25%-5.50% range since last July. The minutes of the central bank's June 11-12 meeting, which were published on Wednesday, showed policymakers acknowledged the economy appeared to be slowing and that "price pressures were diminishing."
Average hourly earnings rose 0.3% last month after advancing 0.4% in May. In the 12 months through June, wages increased 3.9%. That was the smallest gain in wages since June 2021 and followed a 4.1% rise in May. Wage growth in a 3%-3.5% range is seen as consistent with the Fed's 2% inflation target.
Despite the underlying softer details, the employment report was consistent with continued economic expansion. Gross domestic product estimates for the second quarter are around a 2% annualized rate. The economy grew at a 1.4% pace in the first quarter.
Still, the second straight monthly increase in the unemployment rate could be signaling a rise in joblessness. The household survey from which the jobless rate is derived showed employment rebounding by 116,000 in June. The unemployment rate has increased six-tenths of a percentage point from a low of 3.5% last July.
The number of people experiencing long spells of unemployment increased 166,000 to 1.516 million, but fewer people reported working part-time for economic reasons.
The labor force participation rate, or the proportion of working-age Americans who have a job or are looking for one, rose to 62.6% from 62.5% in May.
The participation rate for prime-age workers, those aged 25 to 54, increased to 83.7%. That was the highest level since February 2002 and was up from 83.6% in May.
"The labor market chugging along for now, but evidence is mounting that if it continues to slow down, it could stall," said Nick Bunker, the economic research director for North America at Indeed Hiring Lab.
(Reporting by Lucia Mutikani; Editing by Chizu Nomiyama and Paul Simao)
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